Pay Down the Mortgage or Invest More? A win/win question.

There’s a thoughtful debate going on right now over in the Money Mustache Forum, where people are comparing different strategies for investing in rental houses.

Some people prefer to save up the full purchase price of a house before plunging in and making the move. Others will make the buy using a mortgage but then pay down the principal as aggressively as possible. Still others will borrow 75% or more of the purchase price, then leave the balance outstanding as long as possible, keeping more of their cash free to make additional leveraged investments.

That’s a landlord-specific example, and not all of us are interested in owning rental houses. But exactly the same thought process goes into deciding whether you should pay off your mortgage as quickly as possible, or pump your surplus cash into stocks and other investments on the theory that the long-term return of stocks is better than the 3.5-4.5% rates that US and Canadian mortgages are currently charging.

It’s a complicated question, because to fully answer it you’d need to consider risk, your personality type, how close you are to retirement, asset valuation and cashflow, and even make a stab at predicting the future. But there is still some good news: it’s a win/win question since either of these strategies involve YOU putting away money in a productive place, which will tend to make you wealthier over time. The Mustachian Way is flexible enough that it will make us all rich relatively quickly, so there is no need to lock on to one particular strategy as The Only Way To Do It.

But just for fun, let’s consider a few different scenarios to compare the effects of payoff and leveraging.

Strategy 1: The Consumer who Thinks he is an Investor
Some of my less Mustachian acquaintances like to talk confidently about the benefits of borrowing money.

“3.5% is the cheapest money you’ll see in a lifetime! I am never paying down my mortgage, I’ll just use my money to make more money!”

This statement is correct in general, but the problem is that it is often used to justify higher consumer spending rather than higher investment. Some people who have said this to me have expensive cars (bought on more of that brilliant low-interest credit), powerboats, and lifestyles that burn most of their salary. But their investment accounts are smaller than even the value of the material things they have bought. These people would be much better off paying down the mortgage, rather than buying additional Mercedes and iPads, because they are currently using the leverage afforded by the mortgage to purchase liabilities rather than assets.

To justify not paying off your mortgage, you have to demonstrate a genuine desire to get ahead through investment. That means having low living expenses (let’s say equal to or lower than mine), and a correspondingly high savings rate (50% or higher). At this point, I will grudgingly admit that you will probably do much better investing in Index funds rather than paying off your mortgage – we’ll get to this in the “Stock Investor” category later in this article.

Strategy 2: The Aggressive Landlord

One of the moderators of the MMM forum is a guy named Joe. He’s a fast-thinking, voraciously-reading, fast-typing type of guy who is on the rocket path to financial independence. He correctly calculates that you can make money MUCH faster when you carry a mortgage balance on your rental houses rather than buy them entirely in cash. Here’s an excerpt from his explanation, edited slightly for compactness:

Let’s say houses cost 100k each, and you have 100k to invest.

You can put 25% down on 4 houses (25k each x 4 = 100k) or 100% down on one house (100k x 1 = 100k). Houses rent for $1200 per month.

Let’s compare the two scenarios.

We’ll use the 50% rule, a conservative rule-of-thumb which assumes about 50% of your gross rent will will go towards vacancy, repairs, long term capital maintenance, property management, property taxes, insurance, etc. Mustachian landlords can easily beat this performance, but for now let’s go with it.

Scenario 1: 100% down, no mortgage payment. You cashflow is $600/month, or $7,200/yr.

But wait, we are also paying down that mortgage. Year 1, your tenants pay down $1,012.19 per house of mortgage, or an extra $4048.76 that you gain in equity.

Total for scenario 2: $13,523

So you make almost double in terms of equity gain + cashflow by having mortgages.

That’s assuming no appreciation. If the house appreciates, you gain 4X as much appreciation. If it drops, GREAT, buy more houses! If you aren’t buying places where the rents more than cover the expenses + mortgages, don’t buy them. Who cares what the “value” is if you’re holding long term. Even if you lose your job, you can cover the payments because the renters themselves more than cover the payments!

But that’s also counting having someone managing all those properties for you (that’s counted in the 50% rule). If you want a side-gig as a property manager, you can save yourself an extra $120/mo on scenario one, or $1440/yr. But if you landlord in scenario 2, you’ll gain an extra $5,760/year. Yes, you’ll have 4x the work (managing 4 houses vs one), but you have that choice – let them be managed and pay for that, or manage yourself and pick up a few extra bucks than you can in scenario 1.

On top of that, you ALSO get mortgage interest write-off. So on top of 2 grand more cashflow, 4 grand principal paydown, 4x appreciation potential, you can write off some of that cashflow. PLUS you’ll have 4X the depreciation, sheltering all that cashflow and perhaps protecting some of your W2 income from your normal job.

Joe goes on to point out that over-leveraging is bad, but moderate leveraging (which we’ll define as 4-to-1 in real estate) works out well. But you must you have the personality type to deal with getting loans, and running a business. Real estate investment is actually a business that takes some skill, rather than just a free-for-all form of passive investing. This skill also allows you to avoid buying houses during property bubbles (Joe’s analysis would have ruled out the overvalued sunbelt properties that later lost 50-75% of their value in the US housing crash).

But if you develop the skill and understand the numbers, there are few ways to make as much money so quickly.

Strategy 3: The Young Stock Investor

You’re just getting started on saving for early retirement. You have a good career that is providing some surplus cashflow. But you are not interested in landlording or you live in Silicon Valley or Vancouver where house prices are far too high to justify buying them as rentals. So you decide to invest in stocks.

Over the long run, people who understand economics will generally agree that stocks will do better than the 3.5% return (before inflation) you get by paying off your mortgage. We’ll leave the explanation to the stock market books, but most would predict about 7.5% before inflation* even given today’s relatively high stock prices.

Being sure to max out your 401(k) is even more important, especially for those with incomes over $50,000/year due to the benefits of tax deferral and employer matching.

Strategy 4: The Conservative Early Retiree

You may notice that I speak favorably of strategies 2 and 3 above, and I have followed parts of them both over the years and benefited (even while living through the great financial crisis, the US housing crash, and two major recessions). But now I operate on an all-cash basis. I have no mortgage on my primary house, or the rental house, and I avoiding the temptation to borrow to expand my investments further. And many other retirees, both early and late, take the same path. Why is this?

I am a wimp: I learned during my heavily-leveraged “Big Mistake” business phase that I do not sleep well when things go wrong while there are monthly loan bills that are still due. But I get great pleasure from cashing rent checks and keeping the proceeds entirely for my family. My analytical side knows that I could make much more income through leverage, but sometimes you can afford the analytical side be damned. When? See the next point.

I already have enough income: Once the groceries and the property taxes and the family trips are paid for, the marginal utility of more money drops significantly. If I had more income, I could spend more, which is definitely not interesting. I could save more, which is slightly interesting. I could give more, which is actually quite interesting, but so far I haven’t gone so far as using debt leverage to achieve it. I’d rather achieve more on the production side of things: working hard on things that force me to simultaneously learn and gain skills, and earn income as a side-effect. Even this blog meets those criteria, although it is heavily tilted towards learning and away from income right now.

Paid-off assets can replace some of the “cash/fixed income” portion of a retirement portfolio: What is better for a retired person: keeping a $200,000 mortgage on your house and having $200,000 invested in corporate bonds that yield 3.5%? Or putting that cash into the mortgage and just having a more stock-heavy portfolio? In general, the mortgage is better since its return is 100% guaranteed and there are no income taxes on saved mortgage interest.

Nobody wants to lend me money anyway: During the years since early retirement, and before switching to the current “all cash” model, I decided to refinance the main house and a few rental houses at various times. As the US credit system tightened, I found it increasingly difficult to qualify for these refinancings, despite the fact that I could prove invested assets greater than the mortgage amounts on the houses. This is because most banks are only set up to handle the typical borrower: someone with lots of income, and negligible assets. When they see that my income is relatively low compared to the value of my house, they assume that I could never handle paying a mortgage. So I had to do much more paperwork and work with special lenders to do these refinancings. Mustachians tend to blow the minds of the regular world, because our spreadsheets do not work the same way their spreadsheets do.

In the end, I respect the power of leverage, but I also came to appreciate the Peace and Quiet of Cash. But that doesn’t mean you can’t take a totally different strategy!

* for the S&P500 calculated roughly as: 2% current dividend rate+3% inflation+2.5% real GDP growth rate. Don’t go crazy writing comments to me about how optimistic this is, I’m just repeating the orthodox view that economic experts (including Warren Buffett) tend to have of long run stock performance.

jack, no one can argue that being debt-free is a bad position to be in. However, I would argue that most individuals and businesses initially need debt during their growth phase. An investor who waits to acquire enough capital through saving will not be able to achieve the financial freedom real estate investing offers.

I say, early in your investing career, borrow as much as you can safely handle, i.e have sufficient cash reserves for vacancies and repairs, then focus on using positive cash flows to power down debt later.

Use leverage to acquire assets sooner rather than later!! Real estate investing is a game of patience, you will achieve you financial goals, but it takes holding properties for many years!

Thanks again for taking a topic that has been misunderstood and explaining it very clearly.

I appreciate your efforts to pass on your knowledge through this blog, as noted in this statement: “I’d rather achieve more on the production side of things: working hard on things that force me to simultaneously learn and gain skills, and earn income as a side-effect. Even this blog meets those criteria, although it is heavily tilted towards learning and away from income right now.”

What’s your take on using existing equity in your home to purchase rental units? I know of at least one person who has done this by getting a HELOC on their (mortgage free) home and using that to outright purchase a rental. Rental then pays the HELOC. I don’t think this is the most efficient way as the HELOC rate has to be higher than a mortgage.

What about doing something similar to get the initial money to execute Scenario 2 of Strategy 2?

I ask because as a Canuck, most of my equity is locked up in my house, RRSPs and RESPs. Taking money from the registered plans results in too many penalties to even consider it.

I don’t have any personal experience but I think using a HELOC can be a good short-term strategy. You can take the funds and purchase the house for cash, then go get a bank loan and pay off the HELOC. Depends a LOT on your risk tolerance of course :)

I recently bought a home using my HELOC. My HELOC interest rate is variable (currently about 5.24%!) and I was planning on paying off the entire balance rather quickly. During a call with my bank I was offered a fixed rate advance on my remaining HELOC balance at 2.99% for a year. I jumped at this opportunity and used the fixed rate advance + cash to pay of the variable HELOC balance. I was not aware that “fixed rate advances” on HELOCs existed but was pleasantly surprised.

“But there’s also that thing where I know how I’m going to feel when I clear off my mortgage. I’ll say, “Ahhhhh … that’s nice. Like a foot massage every morning for the rest of my life.”

I owe $87,829.19 on my mortgage which is at 2.55 percent. I’m applying an extra $1,000 biweekly against it, and with about $52,000 in extra payments coming in from some investment accounts rejuggling, it is going to pay off Apr 5, 2013 according to my spreadsheet. I don’t care that I might make more money elsewhere. The peace of mind of getting and staying debt free for the rest of my life will be nothing short of monumental to me. Things are not well in the world financially, as we all know. It could end in hyperinflation or hyperdeflation. Being debt free will give me a large comfort level no matter what happens.

I’m lucky to have received a work bonus as well. I had the same first reaction. Do I put it in my RRSP? On my condo mortgage? Pay down an investment loan? Or put it in my TFSA to save for upcoming expenses? Putting it down on the mortgage always feels good but this year I am planning to buy a house using equity from my condo as a down payment. So paying down my current mortgage doesn’t have the same appeal.
I’m not sure what my plan will be yet…probably a mixture of those. Any advise?

Man, I wish I didn’t live in Northern New Jersey. The numbers in Scenario 2 are so compelling – but it would be pretty much impossible to find a property that made those numbers work within 50 miles of Manhattan. Until we can figure out where we’ve moving, I’ll be the guy in Scenario 3. Have a mortgage at 3.8% now – and in no rush to pay it off early in lieu of maxing out other savings vehicles (401k, two 529s, etc.).

Great explanation of the various scenarios of paying down the mortgage vs. investing more. I wholly agree that once you hit the “I already have enough income,” there’s no need to take on even the slight bit of risk that proper leverage gives you.

And as you say, for most people who will just waste that money, it’s better to pay down the mortgage, because they won’t invest it (or will, but then increase their spending, because of the phenomenon of the wealth effect).

I will be paying off my mortgage as fast as possible. I am more debt averse and also see the guaranteed return more valuable than possibly gaining a few percentage points per year. That said I will still be investing in stocks, which I have started before I have a mortgage already. Like you aid it is a good problem to have, needing to decide how to make all your extra money become even more extra money.

Hey Poor, I’m in agreement with you. I paid off my house and many say it was an unwise decision. It’s now been so long ago, the house would just about be paid off anyway. But the feeling knowing THERE IS NO HOUSE PAYMENT just never goes away. And it feels reeel gooood;-)

@The Money Monk: Once you are past 4 units (i.e. “Rental Apartments” like you say) it becomes a commercial loan, not residential, and is handled differently.

Commercial loans are evaluated differently, and the nice thing about them is your credit scores and income don’t matter as much, but the building’s NOI and ability to service the debt will matter.

So if you’re purchasing a 30-unit apartment building, putting 25% down, but half of the units vacant, good luck getting traditional financing, likely won’t happen (will have to use alternative financing). If, however, 27 of them are rented, you should have no problem.

You need to find a good mortgage broker familiar with commercial loans. Feel free to start a new thread on the forums for further discussion!

If you’re interested in property management as a job, or as a part-time job, then buying a rental property directly is the way to go. However, if you’re just interested in the investment returns that real estate offers, then buying stock in a real estate partnership is infinitely better. A well-run real estate firm can get returns that are as good if not better than what an individual would get by managing his own properties. You have to pay a percentage point or so to the real estate firm, but that is similar to the cost of hiring a property manager. Importantly, you can sell a real estate stock with a click of a button, and, while you’re holding it, you’re much more diversified than if you own an apartment building. Also, selling an actual property is an enormous hassle, has huge transaction costs, and is stressful for most people. For those who wouldn’t derive pleasure from the hassle and responsibility of property management, it makes much more financial sense to buy real estate partnership stock.

Actually, that’s not true. The upper limit for a fixed rate, conventional loan under FNMA regulations is 10. I happen to have six loans, all 30year, fixed, residential.

There is a 4-loan limit after which you might have to put more down, i.e. 25% down instead of 20% down. This requires finding the right mortgage broker and bank. Some of the more well known banks might not talk to you if are going over the 4-loan limit.

MMM says: achieve more on the production side of things: working hard on things that force me to simultaneously learn and gain skills, and earn income as a side-effect.

That’s where I’m at too. Earning money the way of leveraging and dealing with the headaches and stress is unnecessary. What I want to do now is learn and in any small way, make the world a better place to live. Maybe naive, but that’s my hope.

I think mortgages are different in Canada, in that you can’t get a rate that stays the same for 30 years. So if you’re a landlord, and get the standard 5 year that most Canadians get, you are exposed to interest rate risk after that period. Your profitable property could easily turn not profitable if rates went up a few percent.

In fact, most RE investors I know use variable rate mortgages, to keep the payments down and make their properties more cash flow positive on a monthly basis. Whenever the bank rate goes up, their rate goes up right away, so they are REALLY at risk of interest rate changes!

Never mind all that, though, finding a property with a 14.4% gross return, as in the example, is near impossible here. If they market crashes here, I will be looking to buy, though! Maybe with a 10 year locked rate mortgage, and a 10 year amortization, so no extra rate risks.

My approach to this topic is to pay the mortgage fast, except when markets tank. When they do, I switch all extra cash flow to stocks for the long run.

I like to think of my portfolio as a set of hedges. The first hedge I had in place was the stock market, my prosperity hedge. That is to say, if the country continued prosperous, I was set, because the gains from the stock market would cover my needs. After that, I needed a disaster hedge, which was cash and bonds. That has come in handy the last few years. My husband is a good saver and has always refused to put his own money in the stock market, so he has been my best disaster hedge (Thanks, Honey!).

So when I felt like I had enough in the stock market, we put the extra into the mortgage as a boost to our disaster hedge. Our other hedge is against inflation, which is mostly the house and some Ibonds. The stock market is a bit of an inflation hedge, too.

Rental real estate would be a wonderful inflation hedge, but we’re not quite ready to go there yet.

The hedges are not pure, I guess. But it sort of clarified my thoughts.

Looks like we are on the same track. I own Vanguard funds, too, and I have been thinking of adding REITs to the mix. We also hold a lot more cash, due to my husband’s propensity to save, rather than invest.

I crunched the numbers years ago and came to the same conclusion that Joe did, and I’m working on buying my second rent house with a 25% down payment.

Once I get 4 rent houses, I’m going to have to start paying cash, or paying off existing mortgages. My understanding is that you can only have 4 Fannie Mae/Freddie Mac investment loans at one time. But by the time I have 4 rent houses, I’ll have a lot more cash flow to throw at the “problem.” And who knows, maybe by then I’ll be financially independent, and I’ll be ready to be done with debt anyway!

I now have a sentiment more like MMM’s. Before early retirement, when I was agressive and running my business, I had my home leveraged to help build my business. And I was comfortable taking this risk in my early 30’s. However, once I sold my business and started owning rentals and working at other things (for fun!) part-time, I wasn’t interested in making lots more money or leveraging again. I have also paid cash for everything since early retirement.

I also wanted to add that I have had two rentals, one that always did better than the 50% rule mentioned and it appreciated and allowed me some nice income. The other has not yet gotten me above this 50% rule, because it has only been rented since the 2008 economic downsurge and I can’t get the rent from it mentioned in the article. But the one that did well did not sit well with me because it was in another city, I had a bad renter (after many good ones) who seriously trashed the place and sold drugs out of the place. The police were there quite often. Because of all this nasty business, I sold it and still I made money. Yet, I am quite comfortable to continue owning the rental that doesn’t make the 50% rule, because it is local and I sleep well with the renters I have there.

My point is that my comfort level is important, my neighbors are important and that my priorities have changed since retirement. Maybe I can make some more money doing things differently, but I don’t really care since life seems good and I don’t spend much money.

By the way, I have been systematically investing in various Vanguard funds from when I was leverage and didn’t know anything about investing in the market up to the present, now that I have spend a little time studying the market and analyzing my own feelings about risk and investments. I am now reading “The Intelligent Asset Allocator” by William Bernstein, reviewed by MMM, but reading it is not as much fun as growing vegetables in the garden!

In general, leverage makes you more money. That’s exactly how banks make money, the whole fractional reserve system: they loan (i.e. rent) out significantly more money than they actually have on hand. Most huge corporations are leveraged to one degree or another (take out a loan so we can expand some part of our business). Replace “money” with “stuff” and my first sentence applies to the typical, anti-Mustachian first-world consumer. I think leverage is one of those human constructs that you could argue about at a philosophical level: countless examples abound showing demonstrating its goodness and badness. Of course, the 2008 financial meltdown was certainly worsened by leverage. Leverage is sort of like a catalyst. It makes the highs higher and the lows lower.

Personally, I’m in the “prefer to have zero debt” category. That’s just me. I think MMM makes an astute point that if you’re going to leverage your investments (rental properties or otherwise), then you’re more of a “business owner” than a “retiree”. I’m using those terms very loosely, but having anything leveraged, to me, is in a sense “having a job”. It’s an obligation that you have to fulfill. But at the same time, it’s probably not a 40-hour/week obligation, and the hours should be reasonably flexible. But it does steal more of your time than, say, investing in an REIT.

On another note, in the “FIRE” community, rental properties seems extremely popular… I always get the impression that a lot of people view being a landlord as easy money. I have a single family home that I rent out. And so far, it has been easy money for me. But I’ve heard horror stories that sometimes make me think I’d be better off selling the house and just putting the money in an REIT. I guess the biggest risk is the difference between the tenant’s security deposit and the deductible of your insurance. But I think there’s a lot of non-tangible risks, or headaches if nothing else. What if you get a tenant who just disappears, and for whatever reason, you don’t even know he’s abandoned the property until the rent comes up missing? Now your property is paying zero while you try to find another tenant. What if he agreed to no pets, but anyway brought in an animal that wasn’t house-trained? What if you say “no smoking” but he smokes anyway? What if the guy just decides to be a jerk, and rips up carpeting, puts concrete in your washing machine, and colors on the walls?

These are extreme examples of course, but two minutes of web searching will show you that they do happen. What are the odds? Probably fairly low if you do due diligence (background, reference, and credit checks), but there’s always some chance that the “perfect, quiet tenant of the last two years” suddenly turns your house into a brothel or meth lab or some other travesty. Security deposits and insurance only go so far; you do have some financial liability, and definitely a potential *time* liability. Check your state’s rental laws; some states are landlord friendly and some are tenant friendly. I have a book that describes the eviction process in my state, and all I can say is, I hope I never have to go through it. Even if I was FI and not working a for-pay job, I wouldn’t want to have to do it.

Having said all that, I wonder if you can improve your odds of good tenants by renting to a certain “class”? Obviously, explicit discrimination is illegal, but I’m talking about *implicit* discrimination based on property location and rental cost. My intuition says that if you’re a slum lord (cheap properties, super-low rents), you’ll probably have a lot of headaches. But at the same time, it’s probably hard to find regular tenants for a $1mm mansion. So I would think that there’s got to be a “sweet spot”, between class (i.e. rent and location) versus tenant risk. I would assume the biggest, most successful property management companies probably know this quite well.

So maybe there’s another application of leverage: instead of buying more properties, buy a *better* property, where you can charge more in rent or have a premium location, and possibly better filter out bad tenants.

This is a good point about REIT’s. If you really want a passive investment, there are plenty of these that pay 7-8% yields, and you get no landlord headaches, massive diversity, and instant liquidity.

The only advantage of owning real estate directly versus this seems to be the ability to massively leverage it with mortgages. It’s much harder to get a stock loan to buy a REIT than it is to get a mortgage on a rental property. If you have 100% cash to buy, isn’t the REIT a better choice?

Strategy 1 reminds me of The Millionaire Next Door’s cautionary tale for buying a home. A low 3.5% interest rate encourages many people to buy houses that they cannot afford otherwise. The authors recommended never buying a place worth more than twice your salary (after your downpayment) if you plan on becoming a millionaire. Watching the housing bubble burst for people who overextended themselves was not pretty.

MMM, can you do an article on your recommendations for pending unemployment? (I do not have this issue) I would love to hear your discussion for someone who is being downsized in 6 months. Do you build your emergency fund, stop your retirement savings, cut X amount of expenses?

Generally I’d agree there are some good benefits of paying off your mortgage. However, it isn’t really “zero debt”. You still have the ongoing responsibility for property taxes, maintenance, and insurance costs (together, call them “carrying costs”), all of which compound and worsen as the house ages and as years go by and inflation compounds. Over the long run, the real costs of a house aren’t the small 3.5% a year you pay in interest; it is the carrying costs. A paid off mortgage reduces your monthly cash nut you have to pay, but it really isn’t “zero debt” – because to keep the house you’ll still always have obligations to fund. Just a viewpoint here on how I’m not totally sure there is really a milestone “sigh of relief, now I’m safe” threshold one can logically say they’ve crossed by no longer paying mortgage interest.

‘Over the long run, the real costs of a house aren’t the small 3.5% a year you pay in interest; it is the carrying costs.’

Wha? 3.5% interest on a $300k mortgage is more than $10k/year! The costs you listed would surely be much less than that, unless you had some mansion.

Clearing the mortgage is definitely a major milestone on the path to financial freedom. You’re never free of all obligations, bit dropping that monthly interest cost is a biggie. Once you get all debt down, you still have a monthly obligation for shelter, whether you rent or own, but that can be covered with passive income. That’s the whole goal!

Interest cash costs only go on for 30 years, and drop each year. Carrying costs are forever, and increase with inflation, doubling every 25 years or so.

Consider- you own a $250k house free and clear. Does that mean you’re set? nope- you need perhaps $150k+ in the stock market as well just to cover the carrying costs.

In other words, total assets required to secure shelter isn’t just 100% of the value of the shelter. It is more like 150%+. You need other non-house assets to grow/throw off income to help you cover the house carrying costs.

You’re not “done” nor can you really say you have zero debt when you’ve paid off 100% of the house purchase price. You still need another big separate asset nut for carrying costs.

Actually, Bullseye, I don’t own a mansion, but this describes my situation. I live in an area where housing is affordable but city and school taxes are ridiculous. My house cost 109K and my mortgage was for 87,500 at 4.25%. Of my current monthly mortgage payment, $208 is principal, $226 is interest, $50 goes to insurance, and $470 goes to taxes. My annual interest bill, in other words, is less than half my tax bill. So even though I bought an affordable house (not a mansion), got a great interest rate — this was back in 2004 — when I pay off the mortgage early, in 2017, I will still need to calculate about $500 per month for taxes. And keep savings on hand for repairs and maintenance.

Wow! Where do you live that it costs 5% of your house price for school fees?? I assume income/sales tax must be very low to compensate for this? Where I am (Ontario, Canada), property tax on my $500k property is $3,500/year. But income taxes are quite high, and there is a 13% sales tax on most things except food.

It’s my understanding that the standard amount to put aside for repairs is 1-2% of the value of the house every year. For repairs, we have spent much less than that over the 15 years we have owned our present house. For improvements, we have spent more than that. Obviously, there is no limit to what you can spend on improvements.

But even if I think of nightmare scenarios (new septic system, sewer backup, mold), it seems hard to come up with more than about 2% average on repairs over a period of several years.

Like many others, I am drawn to strategy 4. The simplicity, flexibility, and freedom of a zero debt lifestyle pays intangible benefits that far exceed any leveraged returns from strategy 1.

Of course, if I could go back in time, I would consider strategy 3, instead. That is the best strategy for a simple, flexible, and debt free lifestyle. Provided one shops around and finds a good landlord, renting is SO MUCH EASIER than buying.

The problem with leverage is that relatively benign drops in the value of the underlying asset will have a disproportionate impact on equity. A landlord levered up 80% will see his equity wiped out after a 20% decline in price. The all cash landlord still has 80% of her equity in tact, and in fact is now looking to appropriate leverage to buy the over-levered landlord’s units! In short, use leverage when it would be stupid not to, i.e., the cash flow relative to price is outstanding.

I also like Dan’s analysis of the assets needed to cover carrying costs on the primary residence, although I think you might have to double his 150% figure since some of that passive income needs to be reinvested to grow the asset kitty.

Correct. Leverage works both ways. Leverage means assuming risk. If it wasn’t so, money could be made trivially by always buying stocks on margin.

I wonder, why does my broker offer such incredible low margin rates to me instead of buying on margin themselves? The answer is simple enough: leverage will bite you hard when the leveraged asset price falls and when the interest rate rises (which tends to occur in tandem). My broker knows it, many of his hapless customers don’t.

That bite will be much harder if you’re not liquid enough and will be squeezed out to sell the asset or pay off debt under unfavorable conditions. Compare this to holding unleveraged assets where you have an option to wait. BTW, it is also similar to MMM’s idea of reducing the “emergency cash fund”. This also means reducing your “margin of safety”. The key is to realize that you cannot sell non-liquid assets – or use your credit line – at any time of your choice without being punished.

This same reasoning of course also applies to mortgages. Using leverage is essentially taking on risks which you cannot mitigate yourself (you don’t know what is going to happen with the overall housing market). You may be a lucky winner, or an unlucky loser, but in any case you’re handing off some of your destiny to whims of fortune. The correct way of thinking about leverage is – how sure are you that you can predict future better than the lender? Or: how much do you like gambling?

Take this from someone who’s successfully used leverage to buy high-yielding PFF while FED drove interest rates into the ground. It’s not investing. It’s speculative betting.

My idea on this is to split discretionary savings equally three ways between mortgage pre-payments, investing, and unexpected short-term cash needs (perhaps a moving from a condo to a house or a wedding). If I choose to not buy a house, then I would take the house funds and throw it equally against the mortgage and investments.

I like the idea of not having debt, but I also see that a 3.5% mortgage interest rate is pretty darn awesome.

I submit that Scenario 3 (young stock investor) is not specifically related to mortgages, but rather a question of asset allocation.

Just as it would be wrong to compare performance of a US Treasury bond against Apple stock, it’s wrong to compare the potential return of paying down a mortgage with the potential long-term return from global equity markets. Mortgages and stocks are different asset types with different risk characteristics.

To your credit, you did touch on this in point 3 of Scenario 4.

On a personal note, after paying down our own mortgage last spring, I am a huge advocate for mortgage-free living. The freedom from the monthly payment is every bit as good as I imagined it would be.

Here’s the way I saw this before I purchased my rental property and paid off my house- at the ripe old age of 22. I recalled the simple pyramid of Maslow; understanding the safety of one’s life (including a good night’s sleep) is at a higher importance than the need for personal growth, or self-actualization. The decision was made and on went life…couldn’t be happier.

If you have a boon at tax time you should fire your accountant or hire one… would the government give you a tax free loan? Why are you giving them one? You do not get back more than you pay so why not decrease withholdings during the year and make the money work for you… SMH reminds me of an H&R Block commercial when folks are excited about a refund. THAT MEANS YOU OVERPAID!!!!!!

My focus is to accumulate assets. Some will be income producing and some will be appreciating type. My only concern with paying down my mortgage is that at these historically low interest rates, the liquidity is hugely valuable. I would invest more at this time.

Great post! I appreciate how you go through all of the options and share the financial implications of each.

I own several rental properties in the U.S. (a duplex and a condo). All started as my primary residence, with a 20% down payment. The last couple of years has seen the value drop, so I’m glad that I had that initial money down!

We moved to Australia last year, and I feel like rental property here is a whole new game. Australia’s major cities are some of the priciest in the world – I’ve blogged about it previously, but our modest 1200 square foot rental home would sell for $750,000 or more.

Australia has something called negative gearing. (Quick Wiki reference: “Interest on an investment loan for an income producing purpose is fully deductible, even if the income falls short of the interest. Any shortfall ends up offsetting income from other sources, such as the wage and salary income of the investor.”) As someone with a higher income, negative gearing could potentially save me money on taxes. But it just seems like a huge risk, especially given that some economists predict that property prices here are due to fall 20-40%.

As an investor who pays cash for houses, let me say a few things. I can get a house cheaper than a buyer who uses a mortgage. More than once I have won bids on properties when my offer was not the highest, but it was a cash offer with a quick close, no inspection contingency, and I had a bank statement to prove I had the money. Sellers like to close, and banks like to delay and pull funding at the last minute. So a cash offer is taken more seriously than a financed offer.

Also, many properties don’t qualify for financing due to their condition. So in that case I am bidding against cash buyers only, which is a much smaller pool, so the price is much lower.

Owning houses is work, even with a property manager. I use a manager but I still end up checking out problems and working on the more serious ones myself to save money. Having 4X as many properties would be 4X the work, and the returns from leverage aren’t 4x as high.

Closing costs are much higher when you need financing (appraisal, origination fee, etc). All things I don’t pay for when I pay cash.

I never worry about vacancies, losing my job, mortgage payments on my paid-for properties. Peace of mind is priceless.

I am in the same boat as you. I prefer to pay cash on distressed but salvageable properties because no good bank would finance them. Most of the properties I buy are 35-50% of the appraised value. Luckily I do most of the repair work except for major plumbing, electrical and HVAC.

I now consider myself a “conservative retiree” although I still work and will probably do so for the next 3 – 5 years. But I have gone through the other stages with less than great success.

Back in the late 90’s I remortgaged my home and dumped money into the stock market just before the high tech crash – then, post crash, pulled my money out thus cementing my loses. I knew nothing about the stock market but got sucked into stories of people making 10 – 20% returns on their money. Greed and then fear drove my decision making.

Conversely, I’ve done better in real estate. In 94 I bought my 1st home in northern British Columbia. Of course a few years later real estate collapsed in value.

By this time, however, I had a family and used the declining prices to buy a second larger home on the cheap. Because I was unwilling to give my first home away I became a reluctant landlord.

Some 7 years later, I almost sold that property when the prices finally returned to what I paid for it. Instead, with prices skyrocketing upwards I bought a second rental property.

Long story short, I sold the two properties in 2008 and 2009 and stuffed proceeds 1st into safe investments that paid 3 -4 %. I now have an advisor I trust and make about 7% return on a diversified portfolio. If the market tanks again, I will pour more money in when prices are low (I hope).

Because of going through highs and lows of both the stock market and real estate and watching the American bubble burst I am better suited to the conservative retiree, sleep at night, mode. Can you make more being aggressive landlord/stock investor- sure. Can you loose more not knowing what you are doing, being motivated by fear or greed and/or being a victim of the crashes – absolutely.

I have a mortgage but I have ‘downsized’, in that I have started a second career and that meant a large drop in salary. I want to pay off my mortgage to have that piece of mind. I may finance future rental properties, but my own home I want to own outright.

Still sorting myself out (accumulating funds for future tuition fees) before I start attacking the mortgage though. Would rather build my wealth debt-free than otherwise.

Adding on to what the other Dan said, to be a good landlord, you have the additional headaches of selecting good tenants, dealing with the constant repairs and upkeep of the properties, and going through the legal shit to try and evict the bad tenants, plus paying for the properties even when they’re vacant. I am definetely in category 3.

You should never underestimate the value of good tenants. College students, unmarrieds ‘trying out’ living together and so forth can become quite the challenge. So many landlords I’ve met with were excited that we were boring and married. Of course, that probably had something to do with the previous college student tenants destroying the apartment and stealing the door knocker.

I’ve been amateur landlording for eight years now and the paying cash vs. carrying a mortgage question is one that I put a lot of thought into over the last few years. After much deliberation I came to the conclusion that the zero (or very little) leverage approach was right for me. I currently own two rental properties free and clear and should be putting 50% down on a third one in a few months. I’ll then pay off that balance as quickly as possible, start building up a 50% down payment on property #4, then rinse and repeat. This process accelerates as you go. (I refer to my personal little strategy as “Operation Snowball”.)

From a purely mathematical standpoint it does actually work out better to carry mortgages as arebelspy does a good job illustrating above. However, peace of mind and quality of life should be taken into consideration when making any significant financial decision and I can assure you that dealing with four tenants is much more stressful than dealing with one. Based on my experience I’d rather have a single property that provides me $1000 per month cash flow than four properties that provide me $250 each. The monthly income may be the same but the second option comes with three additional tenants to deal with, three additional properties that might need a plumbing or AC repair, etc, and three additional properties that will need routine maintenance. In short, the second option is the same amount of cash flow for a lot more time and effort. And when it comes down to it, Financial Independence is really about cash flow.

For the aggressive Donald Trump types, leveraging with OPM might be preferable but for the “live simple and be fulfilled” types, paying cash (and/or paying off existing mortgages) is the way to go.

Aside from arebelspy’s analysis, the best argument I’ve seen for option 1 (4 properties instead of 1) is that with the single property, if that renter defaults or skips out, you are out that entire $1000 of cash flow. Whereas with the four properties, one tenant could bounce and you’d still have $750; and it is highly unlikely you’d lose all 4 at once.

One other note; you have to start somewhere and putting 50-100% down isn’t usually possible for a young twenty something who is early in their career. I didn’t start that way. We lived in both of our rentals before they became rentals and they were financed with traditional loans (5-10% down generally). It was through our own experience and conversations with other landlords that we decided to pay off the existing properties (along w/ a bunch of other stuff) before acquiring new ones. Now that my day job income is so much higher and the rental income is all pocketed, it’s much easier to save up that 50% down payment. So I wouldn’t fault anyone for using the bank for their first property. Just wait until you can be in a position to have at least $200 or more a month in positive cash flow. Anything less won’t be worth the hassle.

I’m generally in the camp that says it’s best to invest your extra cash flow rather than pay down the mortgage early. However, you make a great point about the consumer who thinks he is an investor. It is imperative that you make sure the extra money you have available goes towards investments rather than consumer goods. If you don’t have the discipline to invest the money and not pull it out in the future for a frivolous purchase, then you would be better off paying extra towards the mortgage because it is kind of like a forced savings plan.

I’m becoming more and more of an avid reader of this site, and rental income intrigues me. However, almost all of the scenarios that I see seem completely crazy compared to the housing prices of an expensive housing market like the Washington DC metro area. $100k houses that rent for $1200/mo? Yeah right. I think you’d be lucky to find $300k townhouses that rent for $2500/mo (lucky I said).

Yes! You’ve got it right – being a landlord is MUCH more profitable in non-ridiculous housing markets (which people accustomed to ridiculous housing markets would call “depressed” :-)). In DC, NY, or SF, Toronto and other places, I wouldn’t even own a house at the prevailing market prices – it’s usually a better value to rent.

On the other hand, in the Sunbelt areas where houses are on sale for 50-75% off, smart people with cash are scooping up houses and making a great profit because there is so much safety margin between rental income and the cost of the house.

Investors in expensive cities who are brave enough, are adding houses in remote locations to their portfolios, and if they have the knowledge, I actually think that is a good idea. I’ve got an article about it in the works, based on my own recent trip through Reno, NV.

I currently fall in the cash camp. But, the leverage group has me rethinking maybe that’s the way to go. When determining what to rent the homes for. I recall the post above where 1% was quoted. Does anybody else use this as a base for rental amounts?

Thanks for the post. I guess I’m more of a scenario 2 based guy very similar thoughts to Joe. At 36 years old, I currently own 6 investment homes all ranging between 140-250K in Baton Rouge, LA. Was thinking about purchasing one more since I have some capital and came across this ad so thanks again.

I’d like to share a formula with you guys that I use for calculating returns and where money can be best spent. FIrst off, Joe said it best in the Scenario 2 above so in addition to his comments, here goes:

Lets say you have some capital to invest. For the sake of argument, we’ll say $35K. In my market, rents are about $1/sqft and homes for purchase are about $100-$120 sqft. Having said that, I just purchased a home last year brand new for 160K, 20% down payment(32K) thus leaving me a mortgage of 128K. Financed at today’s investor rate of 4.5 combined with taxes and insurance and my monthly note comes to $870 while my monthly rental income is $1600. This gives me a $730 monthly cash flow or $8760 a year gain. If you divide this number over my original investment of 32K, that gives me roughly a 27% return on investment.

I use this formula for evaluating properties and shoot for no less than 20%. Pretty solid return considering you are for the most part in control. Not to mention all of the above facts as well in Scenario 2.

I would like to see more discussion on using a HELOC and investing in the market. We live in SouthEast Tennessee and are currently in closing for selling our old house in South Florida for $75k (we bought in the early-mid 90’s, so its essentially a wash there.. its been a rental for the past 5 years which has turned me off of being a landlord). There is no mortgage on it, but we have about 27k of a HELOC on our current house here in TN which will end up getting paid off after the closing of selling the Florida house.

Market value of house and land here in TN is over 300k. We have an account at Hanscom Credit Union (hfcu . org) which offers HELOC’s for up to 75% LTV for 2.75% (prime – 1/2%). Getting a HELOC for 200k should give me roughly monthly payments of $460 while market returns of 7% would give me monthly gains of $1166 on average not taking compounding into account (yeah yeah, I hear some of you getting ready to reply about the assumption of 7%.. I have no problem with the monthly payment of $460 in the event the market goes down and would probably also dollar cost average the 200k in over a year into Vanguard mutual funds).

More background: We are just into our 40’s, no kids, and have 100k invested right now in mutual funds and already lead a fairly mustachian lifestyle for only having found this site a couple days ago. I am looking at this as a way of using our paid assets to get to early retirement a bit quicker.

Very cool thread!
I have a rental valued at $220,000 with $110,000 owed at 5.25%. 18 years left on mortgage ($740/mo). I have a partner who wants off the mortgage and plans to “gift” me the title (family member). That in itself is proving problematic (equity or adjusted basis). It brings in $1575/mo. Tax and insurance are about $3000 per year. My own home is paid off. I love that freedom! I have the money to pay it off and still have 1 years salary as a prudent reserve. I have been saving steadily for years but am not a fan of the stock market. I put away the full allowable IRA retirement funds in a retirement plan.

I can refi the property (~4%) and keep my cash leaving a payment of $510 (30 yr fixed) with $4000 in closing costs. I would rather have the $1575 (less tax and insurance) and the peace of mind of not worrying about the mortgage. I am an independent contractor (travel a lot) and my employment can fluctuate. The income alone would cover my monthly costs for both places. I am no fan of land lording but property management is too expensive here. I am not looking for more rental property for that reason. I hate to give up the cushion but hate interest payments more.

Whatever I do it has to happen soon as interest rates may go up again. Any ideas? Anyone have a quitclaim gift of property?
Great Blog MMM!

Maybe I’ve missed it MMM, but has nobody pointed out that you only realize the quoted interest rate on a mortgage if it’s kept for the full term? Mortgages are amortized with front-loaded interest which means the early years have a much higher real-life interest rate than the later years. I’d be curious to know how many mortgages go to full-term but I’d guess it’s less than half due to selling the home or refinancing. The real interest rate needs to be calculated based on how long you really keep the mortgage. If you’re restarting mortgages every 5-10 years then you’re paying EXTREMELY high rates in reality, not the cute 3-4% you see on the commercials.

Actually, you are paying the stated rate throughout the life of the loan. The reason the interest portion goes down over time is because you are paying the stated rate on a lower and lower principal balance.
Consider a 100K 30 year loan at 5%. Payments throughout are about $537/mo, or $6444/yr. In year one, you pay $5K in interest, that’s 5% of the outstanding loan balance. The rest ($1444) goes to principal. Fast forward five years. Your payment is still 537/mo, or 6444/yr. By now, your balance is down to around 91K. As a result, your interest payments are taking about $4560 of the $6444, and $1884 goes to principal. The 4560 in interest still represents the same 5% of the outstanding loan balance. (91,000 * 0.05 = 4550)
To recap, if the rate is fixed at 5%, then throughout the life of the loan you are always paying 5% interest on whatever balance remains outstanding on the loan at that time.

Hi Cam,
Circling back to the original concept of the post, it doesn’t matter if you have 0% equity or 100% equity in the property. The important elements are the current value of the property and the time cost of the money (mortgage rate). The money tied up in the rental and the part financed are both working for you and that was my main takeaway.

I am saving up for a down payment on my first rental property. My question is what to do with the extra cash flow that is coming in from the property. Should I put it in an Index fund or pay down the rentals mortgage?

We have enough money to pay cash for a rental. But we have a mortgage on our home. We don’t like owing money so were not sure what to do. Pay off our mortgage and save for down payment on rental. We would not feel comfortable holding two mortgages it would stress us out. This would be our first rental., we have been wanting to do this for a long time

I’m 39 and have decided to pay down and/or pay off my mortgage. I currently rent a room in my house for $400/month and I’ll use that towards the principal. I also (after engaging in this blog) sold my new car which was costing me about $400 which I will also put towards the principal. My mortgage insurance is about to drop off which will save me $70/month which I can also use towards the principal. Essentially all of this money is something I’m used to not having as part of my paycheck. Over 8 years, it will pay off my mortage. With a little extra work, I can get it down to 5 and still meet my retirement contributions. That means my last 15 years of working life, I will have no monthly expenses other than taxes and insurance. Or, I can move out of this house and take a home equity loan out to purchase another house and use income from a renter ($1000+/month) to pay in part for mortgage on another house. As far as liquidity goes, I live near the university and houses here are always in demand, though price fluctuates based on the market. Having an asset that’s worth about $190k in 5 years is highly appealing!

If you go the route of leveraging, you get an added bonus that there is 2-4% inflation per year,
example) You buy a house that costs 100k with a 30 year loan, you put 25k down and owe 75k, after 20 years you still owe more than $25,000, but because of inflation(I’ll use 3%) it will be more like you only owe $15,000.

To pay off the mortgage, or keep the money to invest… I read MMM’s comment somewhere that if mortgage rates were 6%, it’s an easy call to pay it off asap, but at today’s 3-4% levels, it is a closer call, probably a wash. Personally, I think that with rates this low, it is – dare I say – an “anti-mustachian” form of wasteful “spending” to pay the loan down.

Consider:

(A)
Own home with FMV $1M, no debt. (HEQ=$1M)
$300K in retirement accounts
$200K other cash, stocks and other liquid investments
NW = $1.5M

Is A better positioned than B, simply bc he owns his home “free and clear”?
To me, that makes no sense. B has the option to switch to A at will, by just pulling the 500K from cash to pay off the mortgage. Similarly, A has the option to switch to B by simply doing a cash out refi for 500K — However, A is at the mercy of the bank, since he will have to qualify for the loan. Which he will not be able to do if he has retired from the work-for-pay life, since lenders rely on income not NW to qualify loans. If A waits to borrow, he also has interest rate risk, since rates might (and almost certainly will) go up, but they can’t materially down from here. B has already qualified (while he was earning the income needed to qualify), borrowed, and locked in his rate, and he now controls the 500K cash. He could let it sit there in cash at zero risk (and pay 3.5%, really sub 3% after tax) for the piece of mind of having control of that money; or he can invest it at very low risk and be all but assured of earning at least what he is paying in interest (and probably more, since sub 3% is very easy to beat over a medium or long term time frame); and he can simply end the arrangement at any time, at his option, by simply paying off the mortgage without penalty or risk. Additionally, B holds a very valuable “asset” that A does not: a contractual arrangement with the lender that will allow him to keep on using the money at a price of 3.5%, EVEN IF interest rates in the world around him go higher, as they almost certainly will. Imagine it is 5 years later, and rates for a similar product have doubled to 7%. For B, there is now a powerful arbitrage opportunity, he is now GUARANTEED to generate enough return to pay the interest plus take profit with near-zero-risk, since secure yields in that environment (Treasuries etc) will move above his cost of capital (still 3.5%, or sub 3% after taxes).

The only seeming advantage to A is that his cash flow requirement is lower, bc he does not have a mortgage payment and B does. However, this apparent advantage is illusory. The true cost of that payment for B is only the interest portion (the principal portion moves from his cash pocket to his HEQ pocket, a wash as to his NW), and if he has income to offset, he gets a tax deduction on that interest as well, so his true cost is the after tax amount. That cost is offset by any income the 500K is earning him, which as noted about is probably >3% and thus his true cost is negative. Put another way, A is actually the one “paying” more, since he is missing out on the opportunity to invest the borrowed cash at a rate in excess of the after-tax mortgage rate.

I suppose another “advantage” to A is the fact that he can’t do anything stupid and blow the borrowed money. B does need to exercise prudence and caution in investing the loan proceeds. Perhaps that is too much of a burden for some people, but for dedicated mustachians that is not a concern.

Over the long-term (113 years to end of 2013) UK equities have returned a nominal geometric mean return of 9% a year / an arithmetic mean return of 11.3%. By the same measure bonds have returned 5.4%/6%.

If you can lock in a fixed rate mortgage for around 4% today for a decade, say, then I personally like those odds. Even better a mortgage is not marked-to-market (so you don’t face margin calls if house prices oscillate) and most enable some measure of flexible repayments (so you can overpay if the prospective return from equities looks poor).

Moreover there are different ways to effectively borrow to invest via a mortgage. Using an interest-only mortgage is riskier (because you will face sequence of returns risk on the repayment date, although this can be mitigated as above with earlier repayments) versus a repayment mortgage, where you believe you can safely pay off the 25-year term from salary etc, and save on the side into equities (which is what most people actually do in reality with a pension).

There’s nothing wrong at all with paying off a mortgage first, but there’s a risk/reward justification for other strategies, too.

15 year versus 30 year loan on a rental property. Like many of you I’m most comfortable not having debt yet at the same time I like my money to work hard for me while minimizing my risk. I purchased a rental property last year with a 4.625% – 30 yr mortgage. I’ve been looking at refinancing to a 15 year at approximately 4% since I could still cover my mortgage, taxes + insurance and have money to spare each month. I’m currently putting all my extra rent towards paying down my mortgage. If I refinance I’d pay off the mortgage a year earlier then just putting the extra money towards the 30 yr mortgage. Any thoughts on 15 yr versus 30 yr loans for rental properties?

Investing may earn you more based on oft-quoted long term averages but, consider this, if the market tanks by 50% in one year, it would take over 7 years of so called “average stock market returns of 10%” to return to the same position you were in just prior to the loss, and that is not even factoring in inflation.

Consider also the possibility of experiencing a period of unemployment during this period whilst still having to meet your mortgage repayments. Suddenly, leveraging your mortgage to invest doesn’t seem so appealing after all.

I believe someone once said “rule number 1: don’t lose money, Rule number 2: don’t forget rule number 1″. You have to admit he has a very good point.

I currently own my personal residence free and clear (built it myself with cash).
I have mortgages on 3 rentals already.
I have enough equity in one property that I could re-finance and have the cash to buy land and build a brand new house. The current mortgage would only increase by 200/month, but my cash flow from the new house would be 600/mo. And this property would be free and clear too….

Any thoughts on this. Or suggestions to do something else. Have a full time job but have built several houses on the side over the years.

I too chose the risk-averse approach of paying off the mortgage. As of today, I’m about $6,000 away from done, with $3,000 sitting in escrow that of course the mortgage company won’t apply to the principal. I recognize that I probably would make more invested in the market in the long run, and I’m locking up a ton of capital in the house, but I’m looking forward to being debt free in a month or two, and I like the idea that both my house and traditional retirement accounts (already sufficiently funded) will be taken care of, which then frees me up to invest in the market to build my early retirement stash. The positives of that approach are that I will be less concerned about risk in the market as I invest because I don’t really “need” the money to meet any bills, and if I had to, with a guaranteed roof over my head, and long-term retirement taken care of, I could handle basic needs relatively easily if I lost my job or wanted to switch to one that pays substantially less. Paying down the mortgage also allowed me to add a home equity line of credit as a safety net, which has allowed me to forgo a large emergency fund. Again, I concede that this is a super risk-averse approach, and may have delayed early retirement by a year or two, but it has eliminated a lot of financial stress for me, Plus, it’s been fun to pay the mortgage off!

Paying off the mortgage early seems madness while I only pay 1.39% interest. Putting the money into Stocks & Shares and giving it the chance to earn 4% + seems more sensible. Yet, I know that the low interest rate scenario is a short-term thing and that mortgage payments will rise massively soon. So any money overpaid on the mortgage now will make repayments easier later.

But stock market investing is so much fun! And that’s the hardest part about putting money into the mortgage. It’s dull city.

So many other factors to figure too – housing market crash?, effect of inflation on prices (will the mortgage seem so much in 10 years time?), living today rather than tomorrow (you know, maybe it would be nice to have a holiday while you’re young enough to enjoy it properly), etc.

Behavioural economics teaches us the pain of regret associated with a loss is about double the pleasure associated with a gain. Being in the same boat as you (pay down debt vs invest) it’s helped me to ask the question, “Which decision, if wrong in hindsight, will cause me the least regret?”:

Wrong decision #1 (debt pay-down): house paid off but stock market doubled during that time.

Wrong decision #2 (invest): market tanks by 50%

For me anyway, #1 would produce less pain- I’d rather miss the boat than get run over by it.

Keeping the mortgage and investing is the mathematically sound decision.

You will very likely end up with more money in your pocket if you pay off that mortgage as slow as possible. If you’re okay with the extra added risk (and I’d say the market returning less than 2.75% long term is a pretty low risk, IMO – many high quality companies pay dividends higher than that, and that’s then not counting the stock price going up at all), I wouldn’t pay the thing off.

I enjoy reading this post and comments. I have done both scenarios, high leverage(10% down on a property and then taken out a heloc on that one to buy another) and have also paid off rental houses (yes it is kind of boring and you start eyeing that money sitting there). Leverage is great when things go up, but can take you out of the game when things go down. I think one thing that kept me in the game in 2008 and 2009 when many of my friends defaulted was that I had fixed 30 yr loans. I paid a little more than for an ARM, but I also survived the bad times and was able to buy more rental properties when others could not because of foreclosures on their credit record.

I think one thing people aren’t mentioning is your age in life. It makes more sense to be #2 aggressive early on, and amass as much as you can in net worth, and then move to #4 later in life (or “next phase in life” in case you want to retire early). I took much more risks before the gray hairs started coming in. Currently I have 6 properties that cash flow well enough, so I don’t really have any desire to pay off the 30 year mortgages at 4.5-5%. Luckily, I made about 21% last year in stock investments which is a much better return than having paid off my mortgages. I also have a strong income so the passive losses from the depreciation and mortgage interest expense are just piling up and waiting for me later on. If I don’t sell the properties, I’ll likely have many years of tax free rental income in the future. And yet, I am planning to pay down some of each of the mortgages so that at a specific target age, all are free and clear. This is just a birthday present to my future self and really just a move towards simplification and ‘enough.’

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